Annual Report 2012 - May 2012

In 2011, the residential market got off to a slow start, while the commercial market started off strong, then faded a bit toward the end of the year. Overall, the U.S. flooring market grew by 3.5% last year, according to Market Insights/Torcivia, to $16.593 billion at the manufacturer level.

In just a few months, the housing market reversal will be six years old, and it’s still a long way from healthy. Since 2005, the market has shrunk by about 40%, from 7.08 million homes annually to 4.26 million. And during that time, the average home value has fallen 36%. While it has become clear that the housing market will not be falling any further, and signs in recent months in fact point to a growth market, few expect a dramatic rebound any time soon. There is, however, a school of thought that believes in such a rebound, factoring in the number of buyers who have been waiting for the bottom to jump in.

Last year brought with it a winter of historic intensity in many regions of the country. Record snowfalls in January and February seemed to freeze solid much of the eastern part of the country. As a result, huge numbers of projects, particularly on the residential side, were put on hold. Increased business in the balance of the year was not enough to lift residential flooring sales into positive territory.

Weather is a bigger factor on the residential side, largely because scheduling a job is in the hands of fewer people and timelines are more flexible, especially if it’s a remodeling job. On the face of it, one would expect that projects would be delayed until weather improved, resulting in a bump in the summer months, but it’s probably not a one-to-one conversion. When money is tight, like it is for a lot of consumers, the funds put aside for big-ticket items like flooring renovation don’t stay idle long, and are often reallocated to other needs, leading to a whole new cycle of saving in order to approach the project again.

Most manufacturers are reporting solid growth in the first quarter of 2012 compared to the first quarter of 2011, and some have pointed to this as evidence of a returning market. But while the market may in fact be strengthening, comparing sales from a record cold and snowy winter to those from a record warm and dry one may not be the best way to predict market trends. Unless, that is, we start seeing something like double-digit growth.

SECTOR UPDATERight now, what’s having the biggest impact in the residential market is the shift from single-family homes to multi-family homes. In 2010, multi-family accounted for 20% of housing starts, and in 2011 that number jumped to 29%. The multi-family market is a low margin, high volume business for flooring providers, and most of the big manufacturers have dedicated programs to that sector.

While the multi-family market may be strong, it’s worth noting that it represents significantly lower square footage per inhabitant than in the single-family market. The spaces are smaller and more people are living in them. That translates to less flooring per person. These big shifts from single-family homes are having the effect of shrinking the residential flooring market. On top of that, multi-family flooring is about as entry-level as it gets, so to some extent it becomes a race to the bottom.

However, the high end of the residential market is actually doing very well, as evidenced by the sales volumes of manufacturers specializing in that part of the market—like the Dixie Group, which posted 17% growth last year. This year, there are indications that the high end may not grow at the same rate as the last couple of years, but all signs point to continued strength at that end of the residential market.

That hourglass shape, with activity at the high and low ends of the market but significant weakness in the middle, is ultimately a reflection of the state of the nation, with its shrinking middle class. However, most of that population is not shrinking its way up the economic ladder; they’re either holding onto their money until they see their homes regain value or they’re moving down, going for lower price points and often for DIY products.

Last year, commercial growth was led by the corporate sector, which started its rebound in 2010. The healthcare sector didn’t slow down as much as other sectors because of the sustained demand from the growing number of older Americans. The same ought to be true in education, which is experiencing a similar population wave, but where public funding is involved (mostly in K-12), activity has slowed significantly. Higher education, which relies more on endowments, has been doing better. Government work has also abated, though everyone knew that was coming. New administrations automatically mean increased projects, and all that tends to run out after a couple of years.

There’s plenty of pent-up demand in the hospitality and retail sectors. Because these are spaces with a public face, it’s important to keep up appearances, so pent-up demand can only be held back for so long. While there’s more activity in both sectors, neither has so far shown dramatic growth, so hopes are high that this year will bring good results.

COST INCREASEThis year, while sales were up in the flooring industry, overall volume was down, but those higher flooring prices did not translate into healthier margins. Far from it. Those price increases passed on by manufacturers go part of the way toward mitigating increased raw material and operating costs, and the rest of it is absorbed along the chain, further thinning the margins of retailers, distributors, contract dealers and manufacturers. With the market so competitive, no one wants to risk losing clients because of the price tag of their products.

There are several legitimate reasons for increases in raw material costs. First there’s the rising cost of crude oil, and that sets the stage for large scale cost increases, including operating and transportation costs. Then there’s China and the other emerging markets, where demand is high, and that pushes up prices too. Refining and processing capacities are a big issue for the various polymers used in flooring, like PVC, nylon, PET, polypropylene and styrene butadiene (for latex and rubber production). Many of these, like nylon and PVC, rely on petroleum, while others, like PET, can be synthesized from byproducts of natural gas.

One of nylon 6,6’s problems is that the market for the key ingredient, adiponitrile, is dominated by only a handful of players—Invista, Ascend and Rhodia. The nylon 6 market, on the other hand, is wide open.

Polyester (PET) fiber has been storming the carpet market for the last few years, taking advantage of the more attractive cost proposition. PET is third, behind polyethylene and polypropylene, in global production, accounting for 18% of the market, and it’s produced from abundant byproducts, so the long-term prospects for PET costs look more attractive than nylon, at least for now.

Another common additive in flooring, particularly in vinyl, is titanium dioxide (TiO2), which is used as a whitening pigment—it’s heavily used in paints. These days it’s also being used in flooring, most notably in ceramic, as a photocatalyst that pulls impurities and emissions from the air. Over the last few years, demand has outpaced supply (capacity in Europe and the U.S. went down during the economic crisis, as several plants shut down), and since then Chinese producers of lower quality TiO2 have been gaining share. Prices have been rising by double digits for the last few years, and the situation is not expected to ease until 2015, according to industry experts.

The good news with respect to raw material price increases is that we seem to be in the middle of a lull. At least for now, polymer prices are expected to remain steady.

HOUSING ACTIVITYLast year, housing starts rose 3.4% to an annual rate of about 606,900 from 586,900 in 2010. However, single-family starts hit a record low of 428,600, reflecting the shift toward multi-family units. Market experts predict that this year multi-family starts will go up another 22%, from 177,000 units in 2011 to 216,000 units, and that single-family starts will go up about 18% to around 510,000. Such volume would mean about four times the growth that was experienced last year.

Home sales edged up 1.7% to 4.26 million; however, that’s down nearly 40% from the peak in 2005. At the end of 2011, there were 1.4 million homes in the foreclosure inventory, which is down 8.4% from the end of 2010.

According to the U.S. Census Bureau and HUD, sales of single-family homes in March of this year fell 7.1% from the revised February figures to a seasonally adjusted rate of 328,000 units (and grew 7.5% from March 2011), though February’s numbers were the strongest since November 2009.

Existing home sales for March were down 2.6% to an adjusted annual rate of 4.48 million, according to the National Association of Realtors. Weather may have played a factor in this, with the mild weather leading to earlier sales than usual, since activity in January and February represented the best winter for sales in five years.

FLOORING SHAREIn 2011, the ceramic tile and resilient flooring categories took share from the other flooring categories, while carpet and rubber flooring also had some marginal gains. Laminate lost a small amount of share as did area rugs and wood flooring (all three lost about 0.5%). Vinyl flooring is the only category to have gained share every year since the start of the housing crisis, thanks to both its low cost and the growth of LVT. Glass-backed vinyl sheet has also been gaining substantial share, but mostly at the expense of felt-backed vinyl. In terms of carpet, it’s the carpet tile side of the business that is helping the category sustain itself.

Every flooring category except carpet relies on imports for a lot of its volume. Last year, imports outpaced U.S. mill shipments in hardwood, rubber and area rugs. Ceramic tile mill shipments grew at twice the pace of imports, and the gap was even wider with vinyl flooring, but the most dramatic was laminate flooring, with mill shipments up 2% and imports down nearly 14%.

In the last year, we’ve seen the demise of Blue Ridge and the acquisition of Amtico, and there are signs that this year will see more structural changes to the industry.

For an indepth look at the various flooring categories, see the May 2011 issue of Floor Focus.

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